Some Loans are More Equal than Others: Third-Party Originations and Defaults in the Subprime Mortgage Industry

35 Pages Posted: 28 Aug 2001

See all articles by Barrett A. Slade

Barrett A. Slade

Independent

Scott D. Grimshaw

Brigham Young University

Grant Richard McQueen

Brigham Young University - Department of Business Management

William P. Alexander

First Union National Bank

Date Written: July 2001

Abstract

We show how agency problems between lenders (principals) and third-party originators (agents) imply that TPO-originated loans are more likely to default than similar retail-originated loans. The nature of the agency problem is that TPOs are compensated for writing loans, but not completely held accountable for the subsequent performance of those loans. We find empirical support for the TPO/default prediction using individual fixed-rate subprime loans with first liens secured by residential real estate originated between 1 January 1996 and 31 December 1999. We find that apparently equal loans (similar ability-to-pay, option incentives, term, and age) can have unequal default probabilities. We also find that initially, the agency-cost risk was not priced. At first, the market did not recognize the higher channel-risk since TPO and retail loans received similar interest rates even though the TPO loans were more likely to default. We also show that this inefficiency was short-lived. As the difference in default rates became apparent, interest rates on TPO loans rose about 50 basis points above otherwise similar retail loans.

Keywords: Mortgage default, subprime loans, third-party originators, multinomial logit, efficient markets, agency costs

JEL Classification: G210, G140, R200

Suggested Citation

Slade, Barrett A. and Grimshaw, Scott D. and McQueen, Grant R. and Alexander, William P., Some Loans are More Equal than Others: Third-Party Originations and Defaults in the Subprime Mortgage Industry (July 2001). Available at SSRN: https://ssrn.com/abstract=281233 or http://dx.doi.org/10.2139/ssrn.281233

Barrett A. Slade (Contact Author)

Independent

No Address Available

Scott D. Grimshaw

Brigham Young University ( email )

Department of Statistics 212 TMCB
Provo, UT 84602
United States
801-378-6251 (Phone)

Grant R. McQueen

Brigham Young University - Department of Business Management ( email )

TNRB 636
Provo, UT 84602
United States
801-422-3017 (Phone)

William P. Alexander

First Union National Bank

Portfolio Reporting and Analytics
Charlotte, NC
United States

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